Accounts receivable is an asset account. It is a representation of all amounts that customers owe to your business for sales made on account. As an asset, it has a normal debit balance. If transactions are incorrectly credited to accounts receivable, also known as A/R, it could result in a negative balance on the books.
One way that accounts receivable can become negative is if prepaid income is recorded incorrectly. It can also happen when a customer makes a payment after you have written off their account
When you sell to a customer and intend to collect payment at a later date, you record the transaction by debiting accounts receivable and crediting a revenue account. If the transaction involved tangible goods rather than services, you will also debit cost of goods sold and credit the inventory account. Later, when you receive payment on the account, you debit cash and credit accounts receivable. This should result in normal balances of debits in the asset accounts and credits in the liability and revenue accounts. Accounts receivable has a negative balance when it has more credits than debits, because it would be the opposite of its normal balance.
Prepaid Income Recorded Incorrectly
One way that accounts receivable can become negative is if prepaid income is recorded incorrectly. When you receive payment for duties not yet performed or goods not yet delivered, you owe something to a customer. This creates a liability for your business, and is called prepaid revenue. If you instead apply the payment to a customer's account and create a credit balance in the receivables, you can cause A/R to be negative. Assets cannot be negative. You have them, or you do not. This account should be a liability account instead, showing that you owe that amount of goods or services to the customer.
Payments After Write-Offs
In the course of doing business and accepting payments after you have provided goods or services to your customer, you will occasionally have nonpayment issues. Businesses age the accounts, or examine how far past due the accounts are. They use this aging report and prior experience to determine how likely it is to collect the debt. The threshold may vary from business to business, but could be months or years. Once the debts are deemed to be uncollectible, you will debit bad debt expense and credit A/R to remove the amount from your assets. Failing to write off bad debts overstates A/R, which can make it look like you have more assets than you can actually leverage to pay for operating expenses and meet debt payments.
Sometimes, a customer will make payment after you have written off their account. A negative A/R balance could occur if you accept the payment without first reversing the entry that wrote off the bad debt. You would debit A/R to increase it back to the balance before the write-off, and credit bad debt expense to reduce it by the amount that is now able to be collected. Then you would accept payment as normal, debiting cash and crediting A/R.
Accounts receivable normally has a debit balance. When A/R has a credit balance instead, it is said to have a negative balance.
Negative A/R actually represents a liability, an amount owed to a customer either for prepayments or over-payments of their account.